Power Talks: Markets are basically ignoring the political chaos

Economists always struggle with the vagaries of politics and have difficulty dealing with the fact that the most scientific economic forecasting and analysis very often gets blown out of the water by the words and actions of politicians, particularly those of the irrational kind. Of some consolation is the fact that economics will almost always win out over politics, but not before considerable damage can be done. Politically, we are now living in very strange times.

Over the past couple of years, the global economy has been experiencing a pretty decent upswing and prospects looked good. However, over recent months the whole outlook has become shrouded in very uncertain and irrational politics and it is now far from clear that the previously anticipated compelling economic growth story over the next couple of years will actually materialise. President Trump has just insulted the two most significant allies of the US in Europe; he has described the EU as the foe; and he is pushing ahead with his totally irrational trade protectionist policies, which if allowed escalate will damage global growth over the next couple of years. He is now even managing to seriously annoy some of his ideologically like-minded and very senior members of the Republican party. Perhaps this is a good thing as it may force him to re-consider the strange path that he is following in relation to global economic policy and political alliances. I wouldn’t bet on that however. In the UK, the Brexit process is becoming more farcical by the day and the dysfunctionality of the political system has to be seen to be believed.

Earlier this week the International Monetary Fund (IMF) updated its global growth forecast and expects global GDP to expand by 3.9% this year and next. This is unchanged from April, but the tone has changed markedly and not in a positive way. It warned that the global expansion is becoming less even and that risks to the outlook are mounting. Growth forecasts for the UK, the Euro Zone and Japan have been revised downwards. Prospects for the US remain positive, aided by the fiscal stimulus injected by Trump. This fiscal stimulus will of course dissipate into next year and beyond, but for the moment, the US outlook remains positive. The IMF is concerned that US interest rates may rise faster than anticipated and that this in turn could strengthen the dollar and damage economic prospects and financial stability in a number of emerging economies. The dollar is still looking very well supported and further strengthening would create problems for emerging economies.

The IMF is naturally most worried about the spread of protectionist trade policies, and so it should be. If Trump continues to pursue this agenda, retaliatory actions will intensify and this would undoubtedly damage global growth prospects. China would be particularly vulnerable, which would not displease Trump, but as the world’s second largest economy, a sharp slowdown in Chinese growth would not be good for any of us.

In the UK, the position of the Prime Minister is becoming more and more tenuous by the day. Agreement on Brexit has, in theory, to be reached by October this year as March 29th 2019 is D-day and is rapidly approaching. The recent statement following the Chequers meeting and the subsequent White Paper on Brexit pointed towards a quite benign form of ‘soft Brexit’, which is clearly what the Prime Minister desires. However, it was never clear how the Prime Minister could possibly have got agreement from the pro-Brexiteers on this compromise approach, and over subsequent days the whole thing unravelled in a pretty dramatic and unedifying manner. On Monday this week she was forced to accept four amendments to the Customs Bill, which in effect have seriously undermined her ‘soft Brexit’ aspirations. It is clear that the pro-Brexit wing of the Tory party is now the tail wagging the dog and the position of the Prime Minister has become incredibly weakened.

There appears to be a growing level of scepticism in Brussels in relation to how worthwhile any negotiations with the very weakened Prime Minister might be. Anything she might agree with the EU, would most likely be blown out of the water by the pro-Brexit group.

Theresa May will struggle to deliver what she desires and the EU will struggle to agree to what she desires. The Tory party is in the midst of a civil war and getting any order out of the current chaos would be no mean feat. It is hard to see how a deal could be achieved by October and any number of possibilities is now possible. These could include a call to extend the Article 50 process thereby delaying the EU exit date; a leadership challenge and a subsequent general election which Jeremy Corbyn would likely win; a second referendum; or a disorderly breakdown of the process and a very hard Brexit.

The reality of course is that nobody has a clue as to how this chaotic situation will be resolved and anything is still possible. From an Irish perspective, the most sensible approach at a national level and the level of every business, is to ramp up the planning for a ‘hard Brexit’. I am not sure if that is the most likely outcome and I have tended to believe that pragmatism would win out in the end, but who knows.

From a market perspective, equities are taking all of this global geo-political chaos in their stride and are holding up remarkably well. That would be likely to change if economic prospects were to change markedly and current political developments certainly have the potential to impact much more negatively on economic outcomes. Complacency regarding current political developments would not be advised. On the currency markets, the dollar is still very well supported, but not surprisingly, sterling is under a bit of pressure, but not as much as one might have imagined. Notwithstanding this, the UK currency does look quite vulnerable at the moment

Jim Power,
Chief Economist,
Friends First

The views and opinions expressed in this article are those of the author.